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The Next Revolution Is Already Here

The last revolution, from an economic point of view, occurred in the mid-nineties when the Internet transformed from a plaything for early tech adopters to a mass product that now, less then twenty years later, threatens the existence of print news publishers and bricks-and-mortar retailers, not to mention postcards, yellow pages and encyclopedias.

The last revolution, from an economic point of view, occurred in the mid-nineties when the Internet transformed from a plaything for early tech adopters to a mass product that now, less then twenty years later, threatens the existence of print news publishers and bricks-and-mortar retailers, not to mention postcards, yellow pages and encyclopedias.

In between, of course, we had mad mass-euphoria that saw one of the largest investment bubbles in history go bust. Most companies that at that time had everyone's interest are today no longer with us, while others have survived through changing business models and new management teams.

Investors may want to take all of this into account when seeking to benefit from the next economic revolution which, I believe, will be equally destructive and transforming while at the same time as unpredictable in its ultimate outcomes as the previous one.

While it is still early days, as it was back then in the mid-nineties, developments can accelerate into new phases and directions at any time as they already have. This is why people inside and outside the industry are divided and unsure as to how and what the future will look like in ten years time. Only one thing is certain: it will be a lot different from where we are today.

The revolution I am talking about is "gas". Technological breakthroughs in recent years have already transformed the domestic energy market in the US, pushing gas prices to all-time lows while at the same time starting a frenzy among entrepreneurs and energy enthusiasts to commercially produce gas from places and sources previously thought of as off-limits. Cheap and abundant gas has rekindled the US political dream of making the country energy self-sufficient. While that may remain a pipe dream in our lifetime, nevertheless from a broader North-American point of view (US plus Canada and Mexico), this ambition certainly looks a lot more likely. This has some political experts already looking forward to a time when the US military is a less likely stabiliser in the Middle East.

That's just one, obvious change that is in the making right now as a direct result of the US gas revolution. With Europe feeling uneasily squeezed between depleting UK oil fields and Russian LNG transported through an Ukrainian pipeline, one can imagine their drive to copy the US revolution on home soil. Similar ambitions throughout Asia need no further explanation. China already knows it has plenty of gas resources. The missing technology and geological analysis are now being imported and developed, suggesting it will only be a matter of time.

The Internet irreversibly changed telecommunication and media. Gas will irreversibly transform the global energy market, including the cozy oligopoly of LNG producers that up till now holds a tight control over the international gas market. Some experts foresee the emergence of business models similar to the discount carriers that has been changing the international airline industry since the nineties. The diamond industry where De Beers once upon a time had full control might serve as another example for the changes that await producers and customers in today's gas market.

Importantly, in all of these cases the ultimate outcome has been "lower prices". The same goes for today's gas revolution. While Henry Hub prices in the US are likely to rise in the years ahead, industry experts believe US gas prices will remain low overall for a long time and this will automatically create extra demand in the years ahead. The US turned into an exporter of coal this year, taking many inside the global industry by surprise. It is likely the years ahead will only see more utilities make the switch from coal to gas, probably with support from government policies aimed at reducing a country's carbon foot print.

While the average car owner might hesitate to switch away from gasoline or diesel, transport companies are likely to prove more easily convinced by the overall cost advantages to their bottom line.

Crude oil prices are amongst the biggest losers inside the commodities space this year, but thermal coal prices have been hit the hardest, losing 25% in a relatively short time span. This is no coincidence. Industry analysts at Standard Chartered who until recently had been very positive on the outlook for the coal sector, changed their view this month after an extensive study of the new market dynamics and how they believe this will impact on producers and prices of thermal coal in the years ahead. Standard Chartered is now negative on the industry's outlook, predicting prices are now in long term decline.

One other industry that might be impacted is the uranium sector. While developing countries such as China are unlikely to cease adding new nuclear capacity in their own drive for energy security, what if countries such as Japan, France and Germany start considering gas as a viable alternative?

On an even broader scale, some experts are predicting a truly new paradigm for global manufacturing wherein access to cheap energy (ie "gas") will replace access to cheap labour as the all-important driver behind success, profitability and survival. It is no coincidence the US has seen manufacturers relocate plants back away from Asian countries. Consider, for example, the average US oil refinery spends 16% of operational costs on labour, but 43% on energy!

It is for this very reason some investment strategists are very positive about the outlook for the US share market and the US economy.

None of this implies that gas producers will instantly become a never-fail investment option for investors. The internet never made Telstra ((TLS)) a good long-term investment (even though it was marketed as such by the Australian government). Investors in the diamond industry have been much better off owning high quality rocks instead of share prices in diamond producers.

"Gas" today is above anything else dominated by regional dynamics. This is why earlier this year the price of gas in Japan was ten times as high as the Henry Hub "spot" price in the US. It is likely some regional divergences will never completely disappear, but if the current dynamics play out as I believe they will (and quite a number of experts agree) then the future consists of a much more open, integrated and interactive global gas market. This means low prices in one corner of the market (US) will impact on prices elsewhere.

As a matter of fact, this process is already happening. With Canadian producers working on plans to access potential customers in Asia at lower prices than offered by the Russians, China has already put meetings about a Russian LNG pipeline on hold while negotiating lower prices with some of its suppliers in Asia. Also, experts are warning negotiated price mechanisms in long term supply agreements agreed upon in the past might prove less sacrosanct in years ahead than producers would like them to be.

All in all, while the immediate outlook for gas prices outside the US continues to look strong, with markets anticipated to remain tight until 2016, it is not difficult to imagine the years beyond will see the low-priced US gas revolution increasingly impacting on a steadily globalising energy market. Of course, there are many dynamics at work and many question marks simply cannot be answered today. What will be the speed of developments in China and broader Asia? How much demand will cheap gas create in the US itself? What more can we expect from technological advances and breakthroughs? Which hurdles will prove more difficult to overcome?

As things stand right now, this longer term development does not seem in favour of producers in Australia who tend to have higher cost levels than most competitors elsewhere. This is without doubt the case in thermal coal, it is also likely the situation in tomorrow's globalising gas market.

Some producers might be hoping for the local dynamics in their preferred supply markets to stay in place for much longer, but even then, Mark Catton, Managing Director of Glencore Singapore recently acknowledged the well known commodities trading house holds a negative view on the outlook for gas and thus prefers other commodities instead.

There are probably multiple important lessons that can be drawn from all this. Be more cautious on thermal coal seems but a logical conclusion to start with.

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